Why Decentralized Finance Has Extremely High Yield But Isn’t Mainstream “Yet”

At least 10% APR made possible for anyone that holds a National ID or passport. No other requirements needed. But?


Decentralized Finance is a new term describing crypto currency related financial products and protocols. Oddly high returns ranging from 10% to 3000% or more have been made possible, and everyone under the decentralized world is equaled and qualified for all financial products. Nonetheless, as it might seem too good to be true, there are a number of unprecedented risks which may lead to completely loss of fund.

Before The Long Story, A Quick Takeaway

If you are not willing to bear the risks of the decentralized world but still wants a higher gain with cryptocurrencies, YouHolder is one of the platforms with 12% APR guaranteed that I have used before (successfully deposited and withdrew my money with the interests). Note that this is backed by a centralized company. Use it at your own risk. To use this platform, you will also have to pass KYC by submitting a photo of your ID.

First, Why Decentralized Finance?

There were times that I doubted if there is a real need for blockchain. Not just a buzzword that is not only slower and less efficient than cloud-based solutions but also cannot scale. Is there any specific application that can only be realized with blockchain and decentralized protocols?

DeFi — The Decentralized Finance Leaderboard at DeFi Pulse

Demystifying Decentralized Finance (DeFi)

So what are the components in decentralized finance? Here we list a few:

  1. Decentralized Exchange (DEX): A platform that lets allows users to exchange tokens through direct interactions with smart contracts. This minimizes the risks of funds stolen by malicious intermediaries. Examples include Uniswap and Sushiswap.
  2. Liquidity Provider: A type of user that provides liquidity to decentralized exchanges. Decentralized exchanges often face a problem: “how can I make sure that there are enough different types of tokens to be exchanged?” To solve this, they give financial incentives to those that are willing to put their tokens into a “liquidity pool” for others to exchange. Usually the gain is calculated from the trade volume of the provided token.
  3. Lending and Borrowing Market: Due to the high volatility of cryptocurrencies market, many users are willing to borrow money with high interest rate for leveraged trading. Another group of risk-averse people would be happy to lend money with the high rate. Examples include Compound, MakerDAO, and AAVE.
  4. Collateralized Debt: Use a cryptocurrency as the collateral to borrow another type of cryptocurrency. Usually the collateral ratio is higher than the value of an asset one can borrow. For example, to borrow 100 USD of asset A, one must deposit 150 USD of asset B. If the price of asset B drops below the collateral ratio (say 149 USD), asset B may be forfeited and the borrower ends up losing 49 USD.
  5. Flash Loan: This is a new type of loan that one can borrow money by just paying the transaction fee and not the collateral. This is only made possible because of the atomic characteristic in blockchain transactions. A transaction can either be valid (cause changes to the blockchain) or failed (nothing happens). If one can borrow money at the start of the transaction and return the money before the end, there would be no risk for the lender. Thus, the only cost of the borrower is the fee to submit the transaction. Example platforms include AAVE and dYdX.

What is NOT Good About DeFi

Now, after explaining the nice part in decentralized finance, here comes the naughty part :P

  1. The returns are usually fluctuating. Sometimes we are overly optimistic about the high APR shown in new DeFi apps. However, that may only last for a week and then drop sharply. No pushed notifications for the dropped return, you must remember and carefully monitor it.
  2. Count the gas price into your total earnings. You may think that frequently switching to DeFi apps with a higher yield is the optimal strategy. However, each operation on Ethereum has gas costs. Gas price on Ethereum can be really expensive. Sometimes even higher than your total interests gained! The gas price is also not a fixed value, it becomes higher when the network is more congested. Check the gas price here.
  3. Make sure which currency the high APR is paid in. When you see numbers like 3000% APR, usually the reward is paid in some new token with little or diminishing value. That means, although you have 3000% APR and the amount of your asset C becomes 30 times in a year, the value of asset C may be dropping from 1 USD to 0.000001 USD within a year, and you end up holding a lot of zero-valued tokens.
  4. Becoming a liquidity provider? Do you know the impermanent loss? Being a liquidity provider doesn’t guarantee all positive gains. To provide liquidity, you often need to deposit two types of asset simultaneously. If the two asset’s price ratio changes dramatically, you will bear more impermanent loss. Calculate your impermanent loss here.
  5. Remember all the different platforms you locked your tokens in. These DeFi applications I mentioned above are independent from each other. A single portfolio in one app does not show the other. One solution is going to another app that summarizes all the tokens you locked in different platforms, like Zerion (see below screenshot). However, if one of your tokens is not supported in this platform, you are not able to see it. Currently I didn’t find a single platform that properly shows all of my locked assets in different DeFi apps. I have to manually keep a record of which platform has how many amount of each token. The platform also doesn’t show your earnings as a liquidity provider.
from Zerion — Invest in DeFi from one place

A Real Life Example

Let’s look at an example when I was using Sushiswap yesterday.

from Zerion — Invest in DeFi from one place
From SushiSwap Discord support channel
  1. Visit Sushiswap (two URL popped up when I searched for this name, so it took me a while to understand the difference between sushiswap classic and sushiswap.fi) and find your token pair at https://sushiswap.fi/pairs.
  2. Before adding liquidity, you have to “approve” the token. After approving, you can finally “supply” the token, which gives SLP (Sushiswap Liquidity Provider) token in return as a proof of your stake.
from https://sushiswap.fi/pair/0xfb3cd0b8a5371fe93ef92e3988d30df7931e2820
from https://sushiswap.fi/onsen
from https://sushiswap.fi/onsen

Total cost

The highest gas fee cost me 6.49 USD, and the total cost for 4 transactions is 6.49 + 1.62 + 1.07 + 2.71 = 11.89 USD. I haven’t even harvest my reward! Besides the actual cost, there are mental costs as well, because you have to make sure every parameter is correct before you sign the transaction.

from Zerion — Invest in DeFi from one place
from https://sushiswap.fi/omakase

Wrap up

Now you’ve learned the background of decentralized finance, the underlying components that made this possible, the risks involved and how to avoid them, and a real life example of being a liquidity provider on Sushiswap.

Berkeley Blockchain Lab | HKUST | NTU CSIE | SCRF@Chainlink | Amateur model (instagram.com/tinaaaaalee) | Projects: github.com/tina1998612